Waste Management, Inc.

Good morning, everyone. My name is Christine, and I'll be your conference operator. At this time, I would like to welcome everyone to Waste Management 2019 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press star, then the number one on your telephone keypad. If you would like to cancel your question, press the pound key. Thank you. It's now my pleasure to hand the call over to Mr. Ed Egel, Senior Director, Investor Relations. Sir, you may begin.

Thank you, Christine. Good morning, everyone, and thank you for joining us for our second quarter 2019 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer, John Morris, Executive Vice President and Chief Operating Officer, and Davina Rankin, Senior Vice President and Chief Financial Officer. We'll hear prepared comments from each of them today. Jim will cover high-level financials and provide a strategic update. John will cover an operating overview. And Davina will cover the details of the financials. Before we get started, please note that we have filed a Form 8K this morning that includes the earnings press release and is available on our website at www.wm.com. The Form 8K, the press release, and the schedules for the press release include important information. During the call, you will hear forward-looking statements, which are based on current expectations, projections, or opinions about future periods. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are discussed in today's press release and in our filings with the SEC, including our most recent Form 10-K and subsequent Form 10-Qs. Jim and John will discuss our results in the areas of yield and volume, which, otherwise stated, are more specifically referenced as the internal revenue growth or IRG from yield or volume. During the call, Jim and Davina will discuss our earnings for diluted share, which they may refer to as EPS or earnings for share, and they'll also address operating EBITDA, which is income from operations before depreciation and amortization, and operating EBITDA margin. Jim and Davina will also be discussing the planned acquisition of Advanced Disposal Services Incorporated, which they may refer to as Advanced or ADS. Any comparisons, unless otherwise stated, will be worth the second quarter of 2018. Operating and SG&A expenses, operating EBITDA, net income, and EPS for the second quarter of 2019 have been adjusted, and projected 2019 results are anticipated to be adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operations, including costs related to the pending acquisition of ADS. These adjusted measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release in the tables, which can be found on the company's website at www.wm.com, for reconciliation to the most comparable gap measures and additional information about our use of non-gap measures and non-gap projections. This call is being recorded and will be available 24 hours a day, beginning approximately 1 p.m. Eastern Time today until 5 p.m. Eastern Time on August 8th. To hear a replay of the call over the Internet, access the Waste Management website at www.wm.com. To hear a telephonic replay of the call, dial 855-859-2056 and enter reservation code 4598118. Time-sensitive information provided during today's call, which is occurring on July 25th, 2019, may no longer be accurate at the time of a replay. Any redistribution, retransmission, or rebroadcast of this call in any form without the express written consent of Waste Management is prohibited. Now I'll turn the call over to Waste Management's President and CEO, Jim Fish.

Thanks, Ed, and thank you all for joining us. Once again, our employees delivered strong operating performance in the second quarter, continuing to demonstrate our strategic focus on leveraging our asset network to serve our customers and drive growth. Just like in the first quarter, the strength of our collection and disposal business was the main contributor to our success. In the second quarter, we generated more than 7% organic revenue growth in our collection and disposal business, with yield of 2.7% and volume of 4.4%. And we had strong core price of 5.4%, which translated into total company operating EBITDA of more than $1.13 billion, an increase of almost 7% from the second quarter of 2018. We also saw operating EBITDA margin expand 30 basis points for the for the total company and 60 basis points for the collection and disposal business. As we've said many times, operating EBITDA is the best measure of the health and performance of our business. And in the second quarter, all indicators point to excellent health. Our operating EBITDA growth translated into free cash flow of $440 million. We're pleased with our year-to-date results, which we will discuss in a moment, but first I'd like to provide an update on the progress we're making towards the ADS acquisition. At the end of June, the ADS stockholders voted overwhelmingly to approve Waste Management's acquisition of the company. This stockholder approval is an important milestone in the process towards closing the transaction. In addition, And as expected, we received a second request from the Department of Justice and we continue to work with them to satisfy this request. We remain on track to complete the acquisition during the first quarter of 2020. We will keep you informed as we continue our progress towards closing this transaction. We have a dedicated team working to position us to successfully integrate ADS upon close. These efforts are important and we're pleased with the progress we're making on that front. Our team is also focused on a number of additional efforts to accelerate our growth and continuously improve our business. We continue to invest in our people, technology, our customer experience, and our asset network. On the people side, we opened our second driver and technician training facility in Glendale, Arizona in June, and we continue to expand our program with Caterpillar to remotely operate equipment at one of our landfills in Denver. While this is a technology investment, It's also an investment in our people, as technology like this modernizes the jobs for our workers, improves safety, enables us to more efficiently work, and provides us with an opportunity to expand our workforce in the future. On both the technology and customer experience fronts, in June, we launched an upgrade at WM.com that allows customers to order and manage service with modernized navigation and increased functionality. We redesigned the site with input from our customers, and so far, it's been really well received. In the first month, we have a 20% increase in customers shopping on the website and an 11% increase in overall online sales revenue. E-commerce is a small but growing channel for us, and we're in the early innings of maximizing its value. Another benefit we get from e-commerce is improving customer loyalty because most online customers enroll in convenient billing and payment options. Finally, on the asset network front, we're seeing great results from our increased focus on enhancing our post-collection business model. Our team is securing expansion airspace capacity in key markets, partnering with communities to ensure that they understand the role that landfills can play in achieving their waste management goals and optimizing our pricing methods to improve profitability and return. In the second quarter, Core price in the landfill line of business was 4% and MSW yield was 3.6%, which exceeded 3% for the second consecutive quarter. This is the highest MSW yield in a decade. It's important for us to drive discipline in landfill pricing to ensure that we earn appropriate returns on this capital intensive part of our business. Our efforts to drive greater discipline in the pricing of our post-collection businesses starts with the transfer station, which is often referred to as a remote gate to the landfill. This focus is also showing strong results with our second quarter transfer station yield improving to 3.4%, an increase of 70 basis points sequentially and 160 basis points from the prior year period. We will continue to focus on maximizing our asset utilization to generate strong returns on all of our assets. We've had a great start to 2019. In the second half of 2019, we expect that our collection and disposal business will continue to generate strong earnings growth and more than offset the decline we now expect in our recycling line of business. John will give a bit more color, but suffice to say we're confident in our ability to execute our strategy, and we are reaffirming our full year 2019 guidance. of adjusted earnings per diluted share of between $4.28 and $4.38. Adjusted operating EBITDA of between $4.4 and $4.45 billion, and free cash flow of between $2.025 and $2.075 billion. And with that, I'll turn the call over to John. Thanks, Jim, and good morning. Second quarter results were strong, particularly in the collection and disposal lines of businesses. Collection and disposal organic revenue growth topped 7%, driven by strong execution on a core price program, continued progress of our strategy around customer differentiation, and robust post-collection volumes at our transfer stations and landfills. On the landfill volume front in the second quarter, growth was driven by the continued strength of MSW volumes, an increase in special waste volumes from a pipeline that remained strong, and very strong C&D volumes as we were able to position ourselves as a community partner to assist with fire cleanup activities in California. The strong volumes that we're seeing in our landfills are also at attractive prices. MSW volumes grew 6.1% and yield was 3.6% in the second quarter. MSW yield of 3.4% and 3.6% in the first two quarters of the year represents a step change improvement from the last several years, and we expect this trend to continue. Our post-collection lines of business are seeing increased operating cost pressures as well as higher capital investments as the costs of construction rise. We will continue to focus on disciplined pricing to recover these costs and generate appropriate returns on our investments in these assets. Turning to our customer focus metrics, churn was 8.8% in the second quarter. Year-to-date churn is 8.5%, a 60 basis point improvement over last year. Additionally, service increases continue to outpace service decreases. The strong collection and disposal organic growth and great operating performance led to operating EBITDA growth of $112 million and a 60 basis point improvement in the margins in those lines of business. In the second quarter, total company operating EBITDA was the highest that we have ever generated. In the second quarter, total operating costs as a percentage of revenue were 61.5%, a 40 basis point improvement over last year, as our operations have been able to improve their efficiency and manage their spending as volumes increase. We still have opportunities for further improvement, particularly around labor, maintenance, and leachate management costs, and our team is focused on identifying and making these improvements. For example, our M100 program provides our frontline supervisors a view of each segment of their routes throughout the day, which will allow for improved efficiency and additional labor savings. We saw early benefits from this initiative in the second quarter as efficiency improved in all three collection lines of business, driving a 25 basis point reduction in labor costs as a percentage of revenue. We expect to drive even greater efficiency improvements in our collection lines of business as we continue the deployment of these tools across the enterprise. Turning to recycling, there was a $21 per ton or 33% drop year over year in our blended average commodity price, down to $43 per ton. But operating EBITDA improved $6 million. We're very pleased with the outcome of our team's hard work to improve the recycling model by lowering costs, restructuring contracts, and assessing fees for contamination. Looking at the remainder of the year, we anticipate that commodity prices will continue to be well below the $70 per ton commodity price we expected when we gave our 2019 outlook. And as a result, we no longer anticipate a full year tailwind from recycling. We now expect that our recycling business will be a $0.01 to $0.02 headwind for the full year. As we've mentioned previously, the traditional formula that a $10 move in commodity prices changes annual EPS by $0.04 no longer holds, due to our successful efforts to change and improve the business model. To emphasize this point, without our team's proactive steps to evolve the recycling business model, the full year impact from depressed commodity prices would likely be closer to a negative nine cents, rather than a negative one to two cents that we're forecasting. We remain focused on changing the business model for recycling with improved MRF technology and contract structures that recoup processing costs and protect us from commodity price downsides. To that end, we are on track to open our recycling plant of the future by the end of this year. With this plant, we expect to achieve labor and operating cost savings while creating the best quality material for sale. Impressively, we fully expect the performance of our collection and disposal business to overcome the headwind from lower recycling commodity prices. As we pass the halfway mark for the year, we anticipate that continued strong organic growth and a focus on operating efficiencies will keep us on target. Our employees have delivered a strong performance throughout this year. I want to thank them for the fantastic job they continue to do servicing our customers and producing breakthrough results. As a leadership team, we're absolutely confident they will continue to perform at high levels to achieve our full 2019 guidance. I'll now turn the call over to Davina to discuss our second quarter financial results in more detail.

Thanks, John, and good morning, everyone. As you heard from Jim and John, the strong performance of our collection and disposal business continued to overcome the impacts of a weak recycling environment. In our second quarter, we again delivered solid financial results. Collection and disposal operating EBITDA grew by over 9% when compared with the second quarter of 2018, driving total company operating EBITDA growth by almost 7% and positioning us well to deliver our full year targeted growth of about 5%. We view operating need of dog growth as the single most important measure of our performance, and we're very pleased to see our operations deliver these results. In the second quarter of 2019, cash flow from operations grew 3.6% to $1,010,000,000. When we normalized the year-over-year comparison for the impact of the fuel tax credits that we received in the second quarter of 2018, the increase would have been 6.7%. We are pleased with this result and see our efforts to convert more of each revenue dollar to cash working. With cash from operations as a percentage of revenue, improving 30 basis points on a year-to-date basis to 24.9%. This is particularly impressive when you consider that we achieved this result in spite of a $66 million decrease in revenue from yield in our recycling business due to the 30% decline in market prices for the commodities we sell. During the second quarter, we spent $578 million on capital expenditures. This compares to $436 million in the second quarter of 2018. The increase in the current year is related to timing differences in our spending for landfill construction, trucks and containers. The difference in timing is the result of intentional steps we have taken to invest in our growth by pulling forward some of our planned capital spending. We remain disciplined in allocating capital dollars to our highest margin and return businesses and have proactively managed our capital spending in 2019 to address our robust volume growth. Volume in our landfill and commercial collection businesses exceeded expectations in the first half of the year, and our operators and their corporate partners have worked hard to accelerate construction and asset deliveries to meet our customers' needs. With the strength of our volume growth, our full-year capital expenditures will be at the upper end of our guidance of between $1.65 and $1.75 billion. In the second quarter of 2019, our business generated $440 million of free cash flow. For the first six months of the year, free cash flow was $871 million. The timing difference that I just discussed for capital expenditures is the primary driver of the decline in the measure from the prior year. Additionally, our second quarter of 2018 included $28 million of fuel tax credits, as well as nearly $80 million in proceeds from the divestiture of non-core businesses. When you normalize for these two items, the year-over-year comparisons for both the quarter and year-to-date period more clearly reflect our strong operating EBITDA growth. We continue to expect our strong operating performance and disciplined capital spending will yield full-year free cash flow in line with our guidance of between $2.025 and $2.075 billion. In the second quarter of 2019, we used our free cash flow to pay $217 million in dividends, and we repurchased $180 million of our stock. When combined with our first quarter share repurchase activity, We expect this level of share repurchases to meet our goal of offsetting dilutions from stock-based compensation. Given the pending acquisition of ADS and our efforts to position our balance sheet well for close, we no longer expect to repurchase additional shares over the remainder of the year. We continue to estimate that this will have up to a negative six cent impact on full year EPS. During the quarter, we successfully executed a $4 billion debt financing, which positions us to close on the acquisition of advanced disposal. The offering proceeds have largely been invested in stable money market funds, though we also used a portion of the funds to retire several of our higher-priced senior notes. We are happy with the results of both transactions, and our average Our pre-tax average cost of debt is now below 4%, which is instrumental to executing well on achieving our targeted returns for the pending acquisition. We estimate that the incremental interest will have a negative 3 cent impact to 2019 EPS. We plan to adjust for both the impact of lower share repurchases and incremental interest costs through the ADS acquisition closing. Our debt to EBITDA ratio measured based on our bank covenants was 2.95 times at the end of the second quarter. This is higher than where we have been in recent years, though well within our targeted levels, which is particularly impressive given that the measure does not yet have the benefit of ADS EBITDA. Our strong balance sheet continues to afford us the financial flexibility to pursue strategic acquisitions at the right price. Turning to SG&A, for the second quarter, our SG&A cost as a percentage of revenue were 9.8%. In line with the second quarter of 2018, despite the increased investment we are making in technology. For the full year, we continue to target SG&A expenses as a percentage of revenue of about 10%. In our business, the second quarter is often an important indicator of how we will perform for the full year. as we observe seasonal increases in certain parts of our business. With the strength of our second quarter results and the positive momentum that we are seeing early in the third quarter, we are positioned well to deliver on our 2019 priorities. With that, Christine, let's open the line for questions.

Understood. Ladies and gentlemen, if you have a question at this time, please press star, then the number one on your telephone keypad. Again, the star wants to ask a question. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Tyler Brown from Raymond James. Your line is open.

Hey, good morning.

Good morning, Tyler.

Hey, John. Obviously, landfill volumes continue to impress. At this point, you're running maybe north of 120 million tons of landfill volumes per but it feels like there's a couple of discrete projects in there like the wildfire cleanup. I know you mentioned the pipeline is robust, but how should we think about those landfill volumes moving into next year? Is there maybe a few million tons that won't recur or anything there would be helpful?

No, I think, Ty, fair question. I mean, you know, we certainly have looked at that, and I think there's a lot of puts and takes with that volume. I mean, we're pointing to the California wildfires this year, which is obviously an unfortunate event to say the least. But if you go back last year and the year before, although the geography changes, we've seen these events year in and year out. It's hard to predict, obviously, where they're going to show up. But I think the other thing you should look at is, aside from just that, is our special waste volumes continue to be strong, and we'll reference that in some of the prepared remarks. So we feel good about the landfill volume. We also look through the transfer stations, as Jim mentioned, the remote gate to the landfill we continue to see. both price and volume performance there. So we feel good about where we're at on the post-collection side.

Okay, that's very helpful.

And then Jim, yeah. Well, I was just going to add to that. You know, it really is almost like event work for us. I mean, and to John's point, it's extremely unfortunate when you have these big natural disasters. We're there to help clean up. We were actually up, Tara and I were up last week, in Northern California driving through paradise. It's devastating. But really, when you boil it down to how it impacts our volume or how it impacts our EBITDA or revenue or free cash flow, as John said, it's a lot of puts and takes. It's very lumpy, hard to predict on an area-by-area basis, but we seem to have, whether it's a big event or a big construction project or a natural disaster cleanup or whatever it is, every year, and so we just look at it as just simply part of our overall business, albeit a part that's tough to predict.

Yeah, no, I appreciate that. But, Jim, maybe kind of coming back to the economic data, I mean, if you look at it across the street, it kind of remains disparate. Obviously your business is doing extremely well right now, but you also tend to be a bit late cycle. So I'm just curious what you're seeing out there, and maybe what are the KPIs that you and the senior management team have really watch that might foretell a trend change in that organic growth metric?

Yeah, you're right, Tyler, about the fact that our industry tends to be considered more of a lagging indicator for the macroeconomy. I would tell you that waste management specifically is a pretty good indicator overall because we service virtually every sector of the economy and What I would say is there are a couple of kind of leading indicators within our numbers. First and foremost, our commercial collection business is somewhat of a proxy for how small business is doing. And when you see service increases outpacing service decreases repeatedly and strongly, to us that's a pretty good leading indicator of how small business is looking at the future in terms of the economy. And then secondly, John mentioned special waste. Our special waste pipeline is very strong. We've seen double-digit numbers now again. And the reason special waste is a leading indicator is because a lot of North American companies, the confidence in the economy shows up in their special waste project work. When they see signs of a slowing economy, they tend to kind of pull in the reins on that event work. and wait until times look a little rosier. So the fact that our special waste pipeline looks as good as it does and the fact that our special waste volumes in the quarters, both second and first, have looked good is a good leading indicator for us. And then the last one, of course, is just C&D volume. And, of course, part of our C&D number is driven by fire volume. But even without the fire volume, our C&D number has been very strong for at least five quarters of Every city I go to seems to have a sea of cranes out on the horizon. So it looks like C&D is still quite strong, and that is also a pretty good leading indicator of the overall economy.

Okay. Yeah, that's helpful. And then maybe, Davina, real quick, what was the divestiture made in the quarter? So, one, you noted it was ancillary. Maybe what was it? Two, is it in that other revenue line? And then, three, just how should we think about divested revenue in in the second half versus the $82 million in the first half just for modeling?

So the $82 million was actually in the first half of 2018. Oh, I missed that. Divestiture activity in the second quarter of 2019 was very immaterial at about $8 million, and that's just normal course asset divestitures.

Okay. Sorry, I got my numbers all mixed up. But is there going to be a lot of back half divestitures or no? No.

There's not currently an expectation of any meaningful back half divestitures. We certainly look all the time for underperforming assets and assets that we can shed in order to be sure that we're optimizing the business model. We're really looking at the reverse side of that and thinking about acquisitions. And you'll see that in the second quarter, we acquired almost $50 million of additional traditional solid waste businesses. And when we think about that in terms of acquired revenue, you're looking at about $120 million of acquired revenue thus far in 2019. What you're seeing is somewhat of an offset associated with divestitures from the prior year. And so there were divestitures both in the front half of 2018 and the back half of 2018 that are somewhat offsetting that strong acquisition growth. but you'll see some of that normalized in the back half of the year.

Okay, that's helpful. All right, thanks, guys. Thank you.

Our next question comes from the line of Michael Finnegar from Bank of America. Your line is open.

Hey, guys, thanks for taking my questions. Just on the MSW yield, the 3.6%, second straight quarter, can you just help us understand what is out there in the market right now that should give us confidence that there's momentum there that we could kind of look at that number going forward rather than stepping back into the old years and the old cycles where pricing was a little bit more competitive. Is it something with the cost pressure, seeing at the landfill that the market now can start passing that through? Is it disruption on the recycling front? Is it some consolidation that's played out? Help us understand some of the factors that is really putting together two straight consecutive quarters of good yield at the disposal.

Yeah, Michael, I think you've touched on a couple of pieces there. Part of it is an increased focus through the use of data and analytics. We brought that to the collection side of the business probably seven or eight years ago. And we've really transitioned that over to the landfill line of business. And now there is not only a use of data and analytics, but there's a real focus on it from our senior VPs as they work with their teams in the field. So that certainly is having an impact. I think that there may be some of it that is kind of necessarily as a result of a few of the cost categories going up, specifically transportation-related costs and leachate management. certainly are climbing at a rate higher than CPI. But I think some of it is just a recognition on our part that these are really critical assets that we have to earn a better return on them. They're very capital-intensive. And so I would say that that 4% core price in landfills and 3.6% MSW yield on the heels of 3.4 is good, but I still think there's opportunity to increase that at our landfills and transfer stations not just to keep up with inflation in certain cost categories, but to help us expand margins. And to me, that's kind of a breath of fresh air after it feels like a decade of 1% yield at the landfill.

That's helpful. And then just lastly, I mean, you know, this year had a nice little benefit from the inflation pickup last year. This year, though, you know, inflation has kind of disappointed, at least on the headline numbers. Can you just talk about what that might mean for us thinking about that going into 2020? And, you know, are some of your business lines clearly seeing cost inflation, you know, above CPI, and the market's going to still have to try to raise pricing to offset that? Thank you.

Yeah, sure, Michael. Really, on inflation and CPI specifically, you know, it's really been flat for the most – flat-ish. I mean, it was down, I think, 10 basis points for the quarter, but – We didn't see really much in the way of tailwind from CPI as it was creeping up over the last few quarters. And now as it started to reverse course a little bit, we're not anticipating much in the way of a headwind. As you said, we do have some cost categories that are outpacing inflation. And so as a result, we've tried to transition some of our pricing of contracts over to that water sewer trash index that that is more representative of our overall cost structure. But there are also a few cost categories that are not increasing at the same rate, such as fuel. So overall, I think we're kind of a bit above that CPI. But we don't expect to see much of a headwind as we move out towards the latter half of 2019 and into 2020, unless something really changes dramatically. I don't anticipate much of a headwind on the price side from CPI solving. Thank you.

Our next question comes from the line of Sean Eastman from KeyBank Capital Markets.

Hi, team. Thanks for taking my questions. First one for me is just on ADS and the HSR review. I can fully appreciate that there's only so much you guys would want to disclose in the middle of this process, but It would be helpful if you could let us know how this review has been tracking relative to initial expectations, and then maybe lay out kind of a rough timeline on what to expect in terms of next steps coming out of this second request from the DOJ.

Yeah, fair enough. This is John. I think in terms of what we've experienced to date, I think it's tracking about as we expected from a timing standpoint, a process standpoint. Clearly, we're not far enough along where we can really start to add any more color or detail. As we said in the prepared remarks, we still think the first quarter of 2020 is on track. I will tell you, the process so far has not yielded any surprises. We're continuing to do everything we can from a regulatory standpoint to make the process with the DOJ go as expeditiously as it can. So in terms of next steps, again, we're not far enough along in the process for us to really add any additional color. But I would expect probably in the next 60 to 90 days, we're going to be further along to the point where we'll be able to add a little bit more color. Sean, I think we all can empathize with you on your impatience here. But unfortunately, when it comes to things like synergies, we gave that original $100 million number. But we don't know anymore at this point because they're still operating as a separate company, and it's not as if we have a team in there kind of diving in right now. That team won't go in and dive in until we close the transaction. And then in very short order, we'll know whether that $100 million is conservative or not. But we're kind of equally impatient. We're waiting for this to run through its cycles again. with the Department of Justice. And once it does, we expect that things will move along pretty quickly.

Yeah, I get that. And I wasn't really trying to prod at an updated synergy number necessarily. I just wanted to understand kind of, you know, even just procedurally what, you know, the next step is in terms of, you know, what will be released by the DOJ or filed by you guys and kind of when that next sort of filing or update would be?

Well, as you've seen, the second request is in process right now. That's probably the only update since the last call. We're obviously working our way to satisfy that request from the regulators.

Okay, got it. Thanks. And then the next one for me is just on the 60 basis points of margin expansion and the collection and disposal business. From a year-over-year perspective, there's quite a few moving parts. you know, in terms of some of the bonus payments made last year, some seasonality nuances, and then this year, you know, some technology investments being made. You know, if there's any kind of additional parsing out you could do, you could provide us in terms of, you know, how much of that was you know, newly gained operating efficiency versus, you know, some of these other nuances I just highlighted. You know, any color around that 60 basis points would be helpful.

I think what's most important in thinking about that 60 basis points is, one, that it's ahead of our expectations for the year. We look for about 50 basis points of traditional solid waste core collection and disposal. margin expansion annually. And so to be at 60 basis points in the second quarter is ahead of plan. What is also important about this is that it's generated in the core business. And so the special bonus that you mentioned did provide about 40 basis points, but that's separate and apart from that 60 basis points that we're really focused on and measuring as an indicator of how our efficiency focus as well as our pricing execution is delivering upon the margin expansion goals of the organization. On the reverse side, the incremental SG&A spending that we've talked about for technology investments is on the SG&A line. And we talked about SG&A actually being flat on a year-over-year basis from a margin perspective. we do expect that you'll see some acceleration of our SG&A spending for digital in the back half of the year. And as a result, you'll see some of that margin pressure from the digital and SG&A costs that we talked about and anticipated come through and normalize out some of the EBITDA margin expansion that we've experienced in the first half of the year. But overall, when you think about the fact that in 2018, we had the fuel tax credits that gave us about 30 basis points of a headwind to 2019 on margin. We've overcome that nicely and generated strong EBITDA margin expansion, and we expect that to continue strongly into the back half of the year and then into 2020.

That's helpful, and nice job this quarter, guys. Thanks very much.

Thank you. Our next question comes from the line of Noah Cade from Oppenheimer.

Hey, good morning, everyone. Thanks for taking the questions. So just wanted to go back to your comments about the commercial service increases, outpacing the decreases, you know, coupled with, you know, the strong industrial yield and a very nice commercial yield. I think you also mentioned that the churn rate was 8.8% in a quarter. Is that right? So that actually ticked up in 2Q. So is that just sort of seasonality? What drove the slightly higher churn rate? How should we think about, you know, that maybe trending going forward as you look at the business?

Yeah, this is John. You touched on it. You know, there was a slight uptick in Q2, but when we look at it on a year-to-date basis, we're still better through the first two quarters. So we're not concerned about that. In terms of what's driving some of the commercial volume, I think Jim mentioned it. in his remarks. You know, we've implemented smart truck technology on our vehicles, and we think that being able to gather data that we otherwise weren't able to is certainly driving some of that volume. Secondly, I think when you look at the churn rate, part of it's being driven by our customer service and customer experience improvements, and it's coming from the lost business that is moderating the business. as opposed to we've done well on the new business side as well, but part of it is coming out of our ability to retain some of these customers. And then lastly, I would say Jim mentioned early, early innings, but I think the experience that customers are starting to have with some of the online tools we've put in place is showing nice progress, albeit early innings.

That's really helpful, Carlos. Thanks. Thanks. And then just a general macro, I mean, your organic growth was outstanding this quarter. I think you broke out at your investor day the revenue mix across different sectors, and that was very helpful, and it's pretty diversified. But just listening to some of the other companies, particularly in the industrial space this quarter, there have been some, frankly, warning indicators around you know, some of the heavy industry, you know, and even in the transport space. And I guess just looking at your industrial business specifically, you know, how should we think about kind of expectations for growth and price strength for the rest of the year? What are you hearing from customers that kind of gives you confidence and sustainability of these metrics you've been delivering?

Yeah, no, I mean, I obviously can't speak to what the other companies are seeing. But what I would say about our volume is, and I mentioned a little bit earlier, the real kind of indicators that reflect the health of the industrial segment are special waste primarily, and then also there's a component of it within C&D, and maybe even MSW, but largely special waste. And that special waste pipeline looks still very strong. I mean, I think there's – and there's reason for optimism there, even on things like coal combustion residuals down the road. So a little bit of that speaks to the lumpiness that we see in our overall business that we talked about early on. Those things are hard to predict, but they come as big chunks of business – and they tend to come every year. We just have a hard time telling where they're going to be and when they're going to come. But I would tell you that this economy has been a real enigma because there isn't a real... clear sign as to the direction of it. And so we kind of have to look at our own numbers and say, what do we think as opposed to what do the pundits think? Because the pundits, heck, the Fed can't even tell you what they think about it. So right now, our numbers look to be still pretty strong. When we look at July, into the month that we're in now, our volume numbers that we look at each week still look strong, and they look strong in the commercial line of business. They look strong in the landfill line of business, and they look fine in the roll-off line of business as well. The one that's been historically weak for us has been Resi, and that's been weak for quite some time, and some of that's just been almost by design. But not to sound like the blind optimist here, in a room full of naysayers, but our volumes look reasonably good.

No, I would add one thing on the industrial line of business specifically. I think if you think about how waste management has positioned itself to be more customer centric and really ensure that as we've grown in the industrial line of business since the last recession, it's been about shifting from temporary business to permanent business and doing that by focusing on our customer. And so I think you're seeing the results of that not just on the volume side of that part of our business, but also on the price side. So we're happy that, you know, the overall focus on the customer is really showing us results, and our ability to retain those volumes, I think, we're better positioned for that today than we were last time around.

Okay, that is incredibly helpful, Carla. Thank you both.

Our next question comes from the line of Jeff Silver from BMO Capital Markets.

Thanks so much. Actually, I wanted to shift back to the recycling discussion. Despite the pressure on commodity prices, you're still able to increase operating EBITDA, which is phenomenal. Can you tell us roughly how many or percentage-wise of your contracts have been restructured to kind of shift the risks over to your customers?

Yeah, this is John, Jeff. We're probably about 40% of the way through, and I will tell you, we think about it in phases. The customers we have on our own backs, if you will, obviously we can get to them generally quicker than the residential customers, the commercial customers, if you will. The volume that's coming into our MRFs directly is another phase we've obviously began to tackle early on. And then the last phase is really a lot of the franchise and municipal customers, which take longer just because the structure of those contracts is generally three to five years, and a lot of times it's related to other lines of business. It's integrated to a franchise, post-collection contracts, et cetera. But to answer your question specifically, we're probably between 35% and 40% of the way through, probably middle innings on the commercial piece and the MERC volume and probably – You know, if you use the baseball analogy, maybe the third inning on the residential side. So we've got room to go for sure. And when you look to your point, for us to see another quarter of continued revenue drop in our recycling team and the field team has been able to improve EBITDA, we're pretty impressive. We're pleased with the progress. We're not pleased with where we're at. We have a bunch of work left to do and plenty of opportunity. Okay. I would suggest that one more point here, and that is that, to what John said about having still 60% left, albeit the tougher group, which are these big contracts. The good news is, if there is a little bit of good news in a really low, kind of 25-year low number, and that is that our argument is a lot stronger when we come into a municipality during a renegotiation and say, look, we're at 25-year lows on OCC pricing. We're getting zero for mixed paper contracts. and this business has really fallen off a cliff, those are real facts that we're bringing to the negotiating table with some groups that have pretty big purchasing power, as opposed to just coming in and saying, look, these are the normal ebbs and flows of a business, and we're in kind of the down cycle right now, but we think it'll come back. I wish I was as optimistic as that. Unfortunately, there's some kind of things that are changing within the recycling business things like Amazon's reduced packaging program and U.S. retail stores. I think the last number I saw was U.S. retail big box stores. There have been 12,000 closures so far in 2019 compared to 6,000 the entire year last year. So there's some permanent changes going on in the business. So if there is a silver lining to a dark cloud, it's that when we go in for renegotiation on these big contracts, We do have a pretty compelling story.

All right, that's helpful. And if I could just ask a follow-up on the ADS merger. Besides the DOJ review, what other milestones should we be tracking before closure?

Well, I think I mentioned earlier one of the previous questions. The second request has been we're executing against that right now. And that, to me, is the next milestone is getting through that. And like I said, I think in the next probably 60 to 90 days, a little bit of speculation, but I think between 60 and 90 days we're going to have some more detail that we can share with you folks.

And while it's difficult for you guys to track this externally, internally we're certainly tracking our integration planning efforts for, you can imagine, a number of back office processes that are not on the customer side and certainly sensitive to how we're thinking about operating two separate businesses through closed. But we've got the right team in place that's focused on integration planning at this point, and that's an important thing for all of us to be tracking within the organization, but not one that you'll be able to see the efforts of externally.

Okay, I understand. Thank you so much. Thanks, Jeff.

Our next question comes from the line of Michael Hoffman from Stiefel.

Thank you all for taking the questions. If I could just close the loop on ADS. Jim, when we were last together a few weeks ago, you suggested that the 12 to 15 months that you thought this would take to get it done now might be more like 12. Is that – that could be a point of an update just to give everybody something to bite on?

Yeah, I mean, look, maybe that's just my own kind of optimism coming out. I just feel like the – Chuck Becker has always looked at me sideways whenever I say that. But I think that based on what we're experiencing so far with the second request, based on the fact that there seems to be a smooth process taking place between the DOJ and our own inside and outside counsel, It gives me optimism that this is more kind of the front end of the range that we've given as opposed to the back end.

Great. And then, Davina, on the free cash flow, could you help us a little bit with cadence? So if I use the midpoint, the 2.05, that leaves you with 1.179 you've got to generate in the second half. How should we think about the cadence of that between the two quarters?

So I think in particular if you look at the first six months of the year, We talked about the capital side, so at about $1.5 billion of capital through six months, we're at about 60% of the full year target at this point. So that's one of the items that is swaying more of the free cash flow toward the back half of the year. The other piece is actually increased interest in taxes, which we talked about in setting our target for the year. We talked about $75 million of incremental cash taxes associated with cash tax planning benefits that we realized in 2018 that would not repeat in the current year. Through six months, our interest in taxes are up $90 million. So what you can see is that we've effectively paid that most of that incremental $75 million that we expected to incur. And those two items really do explain what you're seeing in terms of distribution of cash flow relative to the overall target. But we're still very confident that with the EBITDA growth being the leader of that cash flow generation, coupled with our focus on working capital optimization, we're going to deliver right at that targeted free cash flow. that we talked about of $2.025 to $2.075 billion for the year.

Michael, that's, you know, just to reiterate that one point, that is, I've called it the long pole in the tent, but that EBITDA growth, which we've always said is that's the best measure of the health of business. I said it in my prepared remarks. But, you know, I just don't want that to be missed here. I mean, 6.9% growth in EBITDA is pretty darn impressive, and that's the number we're proudest of as we report today.

Okay, so just to close the loop on my question, and if I follow your line of thinking there, Jim, your next best quarter in EBITDA is 3Q seasonally. So is there anything timing-wise of a normal tax payment or interest payment that would eat into cash in 3Q? And so I'll proportion that 179 and more in the 3Q less in 4Q?

I would certainly say that as that long pole in the tent being EBITDA and Q3 being our strongest EBITDA quarter, we are confident that Q3 will be a very strong EBITDA quarter for us or a free cash flow quarter for us.

And there's not some timing issue around cash outflows like taxes or interest expense that moves that timing around the distribution of the free cash?

That's right. Not in 2019. Okay.

I think the only timing, Michael, might be, you know, Davina's talked a lot about it, but is CapEx. When you can get it done. Yeah, I mean, exactly. I mean, I think Davina, as we discussed yesterday, we're probably 60% through our CapEx spending through two quarters. Now, that doesn't mean you necessarily kind of straight line it from there, but it does give us, you know... optimism that this timing of CapEx in the first two quarters of the year is what's causing this pretty high capital expenditure number. I think the other thing worth mentioning there, Michael, is that when we think about CapEx, a lot of it is about the growth, the future growth of the business. We're spending, you and I talked about this when we traveled together, we're not talking about an immaterial number when we talk about building a brand new, for example, a brand new single stream plant. I mean, you know, whether it's a recycled plant of the future or a single stream plant, when you build it from the ground up and secure the land and put the building on there and then put all the equipment in there, that's not cheap. And that's all for the brand new, you know, recycled plant of the future in Chicago. That's all happening this year. We think that if it proves out the way we think it will, While the impact of one plant on the income statement in 2020 is not going to be material, if it proves out the way we think it will from a process and from an equipment standpoint, this then would start this kind of cascading effect where we replace every one of our single streams potentially with a plant that looks like that. So all that capital is showing up this year, and none of the EBITDA is showing up this year. So a piece of this CapEx... is related to just an investment in our future.

Fair enough. And thanks for that clarity. In the past, you shared with us what your price volume trends were specifically in C&D and special waste. And by the way, thank you for including that new table that shows price or yield and volume by the lines of business. Could we get some clarity on specifically what happened in C&D and special waste in the quarter? Sure. Like you did 10.1 volume in 1Q.

Yeah, I mean, I think I've talked a bit about special ways today. And, John, you can give some color here too. But, you know, special ways, as I said, there's a whole bunch of project work in there. I mean, you know, Mike Watson and his team are very focused on it. We've said that at some point next year, you know, CCRs may start to impact that number, which would be good for us. Right now they're not. And right now it's just a lot of project work. which in kind of reference to the macroeconomy is a good thing as some of these North American companies are using that as I think it's a sign that there still is a level of confidence in the overall economy. But it's hard to point to one thing in the special waste stream. It's a whole bunch of things. And I would say pretty much the same thing about C&D with the exception of the fire volume, which was in there. And so when you look at our C&D volume over the last few quarters, it's been double digits. It has not been as high as it was in the second quarter, but that was really more driven by the fire volume. Yeah, the only thing I would say is when you look at it.

Go ahead, John. No, no, go ahead, John.

All I was going to add was when you look at it quarter by quarter, you can see some of the lumpiness with some of the projects that have gone in and out of the C&D bucket. But as you look at it over the last handful of quarters, the last two years, really, it's been generally up and to the right. And as Jim mentioned, we continue to see strength in that overall. From quarter to quarter, it does bounce around a little bit.

Fair enough. I'm sorry, Michael. One quick point. I do think that's particularly important on the volume side, right? On the price side, we're talking about consistent execution. On the volume side, thinking about the landfill line of business and our outlook for the rest of the year, When you look at the first six months and 4.3% year-to-date of volume growth overall in the company, moderation from things like the California wildfire impact in the fourth quarter of last year, the anniversary of the New York Department of Sanitation contract that came through had a step change late in 2018, we do expect some level of moderation and volumes in the second half of the year from what you've seen in the first half.

Fair enough. And so you did 10-1 in volume in the first quarter and 17-2 in special waste year-over-year growth. What's that number in 2Q for both?

Special waste was 13.3%. And what was the other one that you were looking for?

You had C&D was 10.1 in the first quarter. I was just curious what it was in the second quarter, year-over-year growth volume.

That's where the fire volume showed up, so that measure really isn't one of those that stands alone and tells you what the business did. But if you normalize for the fire volumes and look at landfill overall, our volume growth for landfill was 5.3% in the second quarter.

Perfect. All right. That helps a lot. And then last thing, I mean, I'm correct in the way you've showed the data. You had positive contribution year over year from recycling for your own efforts, but because where prices are, it'll be negative in the second half and therefore negative for the year. Is that the right way for me to model it?

That's exactly right. So the benefit in the first half of the year from the recycling line of business totaled $17 million, or about three cents of EPS. And we're now showing that we expect the back half or the total impact for the year to be a negative one to two cents, which tells you a negative four to five cents of EPS is what we expect in the back half of the year. And that has to do with our execution on the contamination fees and our contract renegotiation efforts that really started to show themselves in the back half of 2018 and anniversaring those impacts.

Thank you very much for taking the questions. Thanks, Michael. Thank you.

Our next question comes from the line of Derek Sprunk from RBC.

Okay, thank you for taking my questions. Are you seeing any pickup in landfill disposal volumes actually coming from recyclable material that otherwise would have been recycled because of the poor economics now, instead of being recycled, shifting into the landfill. And maybe you could, if you could, maybe just touch on the coal ash opportunity as well. Thank you.

Yeah, I would say, this is John, I would tell you on the first question, the short answer is no. We haven't seen any appreciable impact from recycling moving to our landfills for sure. I think One of the things we mentioned on the previous call is, you know, we have the good fortune to have a really talented team in our brokerage side of the business. So we've been able to continue to move material even through the most, you know, the harshest downturn in commodity prices in 20 to 25 years. Yeah, and I'll take the Kolesh question. I mean, one of the reasons we feel good about the opportunity is because we've Since 2010, we've managed over 33 million tons of CCRs for electric utility customers. But there's an awful lot left. We've developed, we think, a really good reputation for the safe, professional handling of that. But there are 700 active and inactive ash ponds in the United States that are covered by state and federal CCR regulations. And so over the next probably decade, those electric utilities are going to have to address somewhere in the neighborhood of 700 million tons. It's a big, big number, and we certainly believe we'll get some portion of that based on past history and based on the fact that we've built a really solid reputation as a good partner in this area.

Are the landfilling economics on coal ash relatively similar to the MSW landfilling?

Yeah, I think so. I mean, you know, in some cases there's, you know, we had a big customer a couple years ago and so the, you know, the margins going into the landfill were comparable. There was a pretty big capital commitment there, but hopefully some of that capital, you know, is reusable. A lot of it was in the form of trucks, some of it in the form of of, you know, monofil construction. So we think that that's going forward. We'll be able to leverage some of that capital that we stepped out for with this big customer several years ago. And so the returns there would be actually better than that original customer.

Okay, that's great. And maybe just one more for myself. If the DOJ determines that you need to divest of more than $200 million of assets Does that derail the ADS acquisition at all, or what are the recourse or mechanisms if that were to occur?

Yeah, the $200 million is a negotiated point between the two parties and sort of an insurance policy if you want to look at it that way. It's not a line in the sand that's going to dictate whether the transaction goes or doesn't go. It's simply a way to get both sides comfortable with the threshold of potential divestitures. But as Jim said and I said earlier, we feel good about where we are in the process. You know, all the feedback we've got to date has been consistent with what we expected, and that's why we remain confident that sometime in the first quarter of 2020 we'll be able to get the transaction closed.

Okay, that's great. That's all for me. Thank you.

Our next question comes from the line of Brian McGuire from Goldman Sachs.

Hey, good morning, everyone. This is Derek Leighton, all for Brian.

Good morning, Derek.

Thanks for squeezing me in. Just one question around input costs in the quarter. Did you guys see anything meaningful in terms of higher landfill operating costs, like leachate generation, anything like that? And if so, could you quantify that?

Yeah. Certainly, leachate continues to be one of the buckets of cost pressure for us, as is transportation. But I think the important thing to note is when you look at the overall margins, And, you know, we've talked at length about core price and yield results for post-collection and specifically the MSW. We're finding ways to obviously combat that and still show margin accretion. So as Davina, I think, mentioned earlier, there are certainly a couple of buckets, too, I mentioned that are outstripping what we would expect from normal cost increases. But overall, I think we're probably tracking in the 3% range from a CPI standpoint.

So, Derek, from a quantification perspective on the current quarter impact, about 20 basis points of incremental cost was from leachate cost acceleration specifically. But that's incorporated in that 60 basis points of overall margin expansion that we talked about for collection and disposal. So it shows you that leachate is certainly one of those cost categories, like John mentioned, that's outpacing CPI growth. But at the end of the day, it's still a component of that 60 basis points of strong EBITDA margin expansion, operating margin expansion that we're seeing in the business.

Got it. That's helpful. Thank you. And then just one last one for me. You mentioned sort of a step change in pricing around the transfer station. What's sort of driving this focus and maybe what's the opportunity for you guys as you look ahead for pricing in this particular segment?

Well, I think we've talked at length about the fact that we've got really well-positioned assets and not just the landfills. As Jim mentioned, the remote gate to the landfills in a lot of cases are these transfer stations, which we think we've obviously, the team's done a nice job of making sure we're positioned in the right places in the right markets. I think that coupled with some of the strain that's been spoken about in terms of transportation network, we've been able to leverage that. And I think that's part of the reason why we're seeing the success through the transfer stations. And I think You know, that certainly there's two components to pricing. One is overcoming, obviously, the cost headwinds that we've spoken to. And secondly is leveraging the position of not only our assets, but the network that exists between those post-collection assets. And I think that's what you're seeing the results of in the last handful of quarters.

That's helpful. Thanks, guys.

Our last question comes from the line of Mark Neville from Scotiabank.

Thanks for taking my question. I think you just answered it, but just the step change in the yield in MSW and transfer in around 3.5%. Again, I think you did clarify this point. You are capturing incremental margin and more than offsetting the cost pressures you're seeing in that business, and that's part of the 60 basis points, correct?

That is correct.

And I think, Jim, earlier you mentioned that further gains potentially on the yield. I'm curious, is that more incremental margin or is it, again, just more offsetting additional cost pressure?

Well, I don't know that we expect these operating costs that we talked about today to continue to climb from where they are. But they are, at this point, running in excess of inflation. So I would guess that that's Continuing to focus on pricing and drive higher price is probably as much margin accretion. But I would say after many years of 1%, 0.9%, 1.4%, I don't feel like I'm doing something that should upset too many folks.

Okay. And obviously with the volume growth, it's not impacting the volume you're seeing in the landfill business either.

No, I mean, and I think it goes to what John said just a second ago, and that is that we really have well-positioned disposal assets around North America. And so that, you know, that makes a big difference for us as we think about our customers viewing it as the next. They do what's considered to be the next best alternative analysis. And in many, many cases, we're the best alternative when it comes to disposal.

Great. Yes, thank you. You bet.

We have no further question at this time. I will now turn the call over back to Mr. Jim Fish.

All right, thank you. And lastly, we've talked a lot about our people today, and I just want to reiterate how important this team of 44,000 people is in producing these results. Without every single person, we could not do what we do. Our reporting today wouldn't be what it was. We continue to make sure they know that by investing in them. And last week I was in Chico, California, meeting with some of our teammates. We're about to open a brand-new hauling facility next week. I'll be in Denver. We're visiting a recently opened energy services building. I mentioned in my script that we're opening a state-of-the-art driver technician facility in Arizona. And I'm giving the go-ahead this week for the fifth year in a row to fully absorb health care increases so that our hardworking 44,000 Employees don't have to pay extra for that very, very important benefit. If you were at our Investor Day, you heard me talk about something called People First, and it's part of that culture. One of the questions that I think was asked was, what's the key ingredient here to waste management's consistency here? in this kind of volatile economic climate. And I would tell you that the answer is our people. And so thank you to all of our 44,000 teammates today for all that you do. And thank you to all of you for joining us today. We'll talk to you next quarter.

Ladies and gentlemen, thank you for joining us. This concludes today's conference call. You may now disconnect.